Minnesota's cabin getaway lifestyle could come under pressure from tax reform

The Land of 100,000 Cabins could be tested by tax reform.

The portion of the House Republican tax proposal that curtails homebuying incentives appears likely to hit Minnesota harder than most states.

That's because the vast majority of cabins in central and northern Minnesota are second homes, which would no longer be eligible for a deduction on mortgage interest under the House GOP tax plan that was unveiled Nov. 2.

Senate Republicans last week unveiled a different tax reform plan that makes no change to mortgage interest deductions. But the markup and voting of tax legislation always starts in the House, creating more debate around the tax ideas on that side of Congress.

"This could impact Minnesota more than anywhere else in the country," said Jeff Forester, executive director of Minnesota Lakes and Rivers Advocates. "It would have a big impact on places that can tolerate it the least."

Across the state, there were 105,000 seasonal cabins and 237,597 residential non-homesteaded properties in 2015. And in Cook, Cass and Aitkin counties, seasonal cabins outnumber year-round homesteads, according to the Department of Revenue.

Thousands of other Minnesotans — snowbirds among them — own houses, condos and getaways in other parts of the country and would lose the ability to deduct their borrowing costs on them.

Mortgage interest deductions emerged in the 1920s and 1930s out of deductions that were originally aimed at business interest, the primary form of borrowing back then. Economists have long criticized the tax breaks for mortgage interest, saying they encourage overinvestment in housing and chiefly benefit the relatively well-off.

"The mortgage interest deduction distorts the housing market, prompting people to take out larger mortgages and buy more expensive houses, and pushing up home prices," the Congressional Budget Office said in a December 2016 report on options to reduce the federal deficit. "People therefore invest less in other assets than they would if all investments were treated equally."

The Joint Committee on Taxation, a nonpartisan panel that helps the tax-writing committees in Congress, estimates that the mortgage interest deduction reduced federal tax collection by $77 billion last year, a figure that will rise to $96 billion in 2019.

Real estate and construction industry groups oppose any changes to mortgage interest deductions.

In addition to eliminating the deduction for second homes, the House tax plan lowers the limit on eligibility for interest deduction to mortgages of $500,000 or less, down from the current limit of $1 million.

That change seems likely to affect fewer Minnesotans since the median price of a home is around $260,000 in the Twin Cities, the state's most expensive real estate market, well below the $500,000 threshold. Fewer than 3 percent of home mortgages are more than $500,000 across the country, according to data from CoreLogic.

Cutting out the deduction for second homes would likely increase the cost of owning a getaway home, stifle sales and put downward pressure on the values of lake cabins and rural retreats.

In several North Woods counties, seasonal property owners are the biggest source of tax revenue that help support year-round infrastructure, including schools and law enforcement.

And across a broader swath of northern Minnesota, cabins and lake homes dominate the real estate market, and the local economy depends on the people who visit. Forester said the average cabin owner spends about $5,000, not including property taxes, every year in Minnesota.

While the real estate market in the Twin Cities has rebounded and sale prices have soared, property values in many rural areas have yet to recover. Kath Hammerseng, president-elect of the Minneapolis Area Association of Realtors, said that eliminating the deduction, which could total several thousand dollars for a typical buyer, will erode the buying power for many buyers by 20 to 40 percent, putting downward pressure on prices.

"In Minnesota and Wisconsin, it's part of our culture to have a second home, and you're talking about the middle class," she said. "It will impact a significant number of people."

There are also several communities where the bulk of the tax revenue is generated by second-home owners, making them vulnerable to an upset in the real estate market.

In 10 of Minnesota's 87 counties, for example, seasonal property owners shoulder more than 40 percent of the residential property tax burden, according to data from the state Department of Revenue. And in several counties, they pay more than 50 percent. Most of those counties are in central and northern Minnesota.

"There will be some unintended consequences that people didn't count on," Forester said. "It could have a cascade effect."

Tom Watson of North Oaks, who spends part of the year along the shores of the Whitefish chain of lakes in northern Minnesota, said, "I'd feel the impact of that right now myself."

He said the loss of the second-home deduction would lead him and others to spend less on other things, from bait to bedding, related to their getaway homes.

Jim Buchta • 612-673-7376